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Removing all doubt

Poor Bernie, he went and opened his mouth and thusly removed all doubt that he has no grasp of economics. Such ignorance from an internet troll might be expected and can be amusing in the same way that a child’s explanation of something can be so. But when such breathtakingly inane statements emanate from a candidate for President of the United States, well, what can one do but weep for the future. To what perplexing attempt at pontification do I refer? None other than this Dec 26 Tweet from @SenSanders: “You have families out there paying 6, 8, 10 percent on student debt but you can refinance your homes at 3 percent. What sense is that?”

Now most people would probably look at this statement and not find it particularly outrageous. We as a society have been conditioned to accept the notion that interest rates are arbitrarily set from time to time by some talking head in government. The assignment of these rates is apparently disconnected from any external factors. They are like lotto numbers plucked from the ball machine. We assume other lenders (banks, credit cards, etc) set their rates in a similar pattern.

In reality non-government rates are primarily market driven. That is, the relative difference in rates is market driven while the net value rests on the arbitrarily set Fed rates. Interest rates are not arbitrary digits, they are prices. They are the price people are wiling to pay to not wait. Interest rates are a reflection of supply, demand, and risk. The demand for loaned funds is indicative of high time preference, that is, preferring something now rather than later. The supply of loaned funds is indicative of a low time preference, that is, the willingness to forego consumption in the present and defer it into the future – for a price. To understand high time preference, ask yourself, do you prefer to buy that 72” OLED 4k TV today, or in a year after saving the funds yourself? Most of us prefer to have it today so that we can enjoy it immediately. The cost of that sooner than otherwise realized enjoyment is reflected in the interest rate we are willing to pay. If there are a lot of people willing to supply loaned funds, then the interest rate will be lower (supply goes up, price i.e. interest rate, goes down). If there are few people willing to supply loaned funds then the interest rate will be higher (supply goes down, price, i.e. interest rate goes up). It’s really not that complicated.

The only wrinkle with interest rates relative to regular money prices exchanged for tangible goods is that unlike exchanging cash for a hamburger (where both parties have something after the exchange), with the process of loaning/borrowing, only one party has the thing they desire in the beginning. The other party has a promise to deliver the other half of the bargain at some future date. The future is uncertain and there is always risk that someone may not do what they say, either deliberately or for reasons beyond anyone’s control. That uncertainty is also reflected in the interest rate. If there is a high chance the lender won’t get paid back then the interest rate will be quite high. But, if something can be offered to mitigate that risk, something tangible, like say a house or a car, then the lender can feel more assured that at least they will get some portion of the loaned funds back in the worst case. So that brings the rate back down.

Bernie, this is why loans backed by tangible collateral (like a home mortgage or equity line) have a lower interest rate than a student loan which has no collateral. A student loan is no different than credit card debt – it is unsecured. Now, look at the interest rate on your credit card (likely over 20%) and compare to the 6, 8, or 10% figure being cited – doesn’t look so bad now does it? These rates are so much lower than they otherwise would be because of government intervention in the student loan market.

Now some might say the banks should be willing to invest in such human capital, that a college degree will translate into a high paying job that allows them to pay it off. That can be true. That is why years ago before government involvement lenders did give out student loans, but only to the most academically worthy of students, those that clearly would succeed. But even so, possible future income is not collateral, the bank can’t take possession of the student himself and enslave him or her to get their money; they can take a house or car, they can’t take a person.

If Bernie wants to help students he should promote the idea of removing government involvement from higher education. Every sector the government subsidizes (healthcare, housing, education) has seen explosive price inflation. That is no coincidence. The patient can’t heal until you kill the disease.

Federally guaranteed student loans are not unsecured. The collateral is a gun to the heads of taxpayers, and for the moment at least, these loans have little downside risk. In nominal terms, even for nominally “private” loans, I doubt that anyone will ever lose a dime on a student loan held or securitized by Sallie Mae.

Limiting interest rates on these loans has more to do with subsidizing higher education (and further inflating its price) than with any credit market, so as much as I disagree with Bernie’s rent peddling, there’s nothing wrong with his economics. It’s just that he’s not discussing the market economics that you discuss here.

These loans encourage many young people (including my children) to waste some of the most valuable years of their lives in often fruitless devotion to parasitic, rent seeking institutions. Many young people would be better off working for low wages in apprenticeships than paying to work for academics with little incentive to prepare them for more productive employment, but the established incentive structure discourages the apprenticeships while encouraging the academic rent seeking.

This trend could reverse in the foreseeable future if employers increasingly accept unconventional training, like Code School and Kahn Academy, in lieu of conventional academic training, and I hope it does. Meanwhile, political forces seek to nationalize higher education and make it “free” for students, essentially extending K-12 public education to K-16. These forces will continue to peddle rents to the academic-financial complex as a stepping stone to their ultimate goal.

Of course, this progress has little to do with the educational interests of students, but that’s beside the point. Extending public education to K-16 gives students a few more years in childhood, which most will accept happily enough, and it delivers rents more directly to the rent seeking academies. That’s what’s important. The parasite must avoid killing its host, but it doesn’t care about your markets otherwise.

I have read through some of the comments and a lot of them are a discussion of Sanders ignorance and how the market for money works, or should work. That is all missing the point when discussing someone like Sanders.
Whether he understands the financial issues is irrelevant. Everything he says is carefully crafted to appeal to his supporters and to those who might support him. His expertise is in reading the public mood and “capitalizing” on it.
We will never know whether he understands the world of finance but I choose believe he knows that socialism will destroy the economy and make everyone poor and enslaved to an elite few.
I make that assumption because I think it’s unwise to underestimate my enemies.
I disarm myself if I think he is just stupid rather than a cunning, power hungry sociopath who will sacrifice anyone and anything to gain that power.

@restonthewind
Greg makes the same point you do, concerning ” our” being the collateral for student loans by pointing out the interest differential between student loans and credit card debt.
Mr. Sanders seems unaware of collateral or and risk. Seems he has never been, (or perhaps even talked to) a saver.

Greg understands the theory he’s discussing, but the theory doesn’t describe the world he’s discussing. A mortgage at 4%, fixed for 30 years, has little to do with anyone’s time preference, no matter how secure the collateral. No sane lender would write this mortgage if he couldn’t flip it to Fannie Mae or directly to the Fed. To school Bernie in economics, Greg needs to study Knapp and Keynes (or Mosler and Krugman) first, because their theories have more to do with the actual, existing economic order.

The state of the U.S. economy is far from any state it would occupy if Greg’s theory actually applied. Some Austrian economists seem to imagine that every economy must, someday, collapse into compliance with their theory, but I doubt that. The cycle of boom and bust seems more like HIggs’ ratchet effect. Growth slows and the economy becomes more frozen into a sub-optimal (in terms of productivity) state with each cycle, but that hardly matters to people as fat as subjects of the United State. We’re on the road to serfdom, but feudalism was not short-lived.

The theory actually does describe the world we’re in, that’s why I included the qualification that the market sets the relative rates while government intervention sets the net absolute rate. So a collateralized loan like a mortgage is 4% while a non-collateralized loan is 20% (credit cards). Absent fed intervention that 4% would probably be say 10% and the 20% perhaps 30% or more. But even then I don’t mean the ratios will be exactly proportional merely that the rates are ordinal: collateralized is always less than non-collateralized. So both home loans and student loans suffer from state intervention but still the collaterziled is lower than non-collateralized. That was my point

Greg, You can try to parse out the “Austrian component” of interest rates and other prices in an economy incredibly far from any state modeled by Austrian economic theory, but I doubt that you can do it meaningfully. The exercise is interesting, but you might as well try to model the space-time around a black hole with Newton’s Gravity.

I’m also generally leary of the “time preference” theory of interest rates. For collateralized credit, like real estate mortgages, I associate the interest rate primarily with the rental value of the collateral, as discussed here. This value reflects the scarcity of real estate on the rental market, not a scarcity of money in savings accounts. People pay rent out of their current income, not out of their savings accounts. Real estate owners renting their property are savers in a meaningful sense, but this saving reflects a desire for income in the present, not for income in the future. Interest rights might signal time preference in some theoretical, market economy, but I don’t swim in that ocean.

A 4%, variable rate mortgage corresponds to something like $330/month on a $100,000 property. I own a condo now selling for only $100,000 (and that’s wishful thinking really), something less than I paid in 2010. My step-daughter lives there, so I don’t receive any rent, but I would be much sadder still if I thought I could rent it for only $330/month. That’s less than half of the going rate. This 4% mortgage has practically nothing to do with consumer preferences for scarce resources (market forces). Neither preferences for housing nor preferences for deferred consumption account for this figure. To understand it, you need an entirely different theory.

“Unsecured credit” is essentially extended against the value of labor or other assets (including taxpayers) that creditors expect, however speculatively, to collect. No sane creditor extends credit with no collateral at all. That’s not credit. It’s a gift. Financial engineers in the political class engineer gifts to their cronies in the guise of credit. Low income beneficiaries of the Community Reinvestment Act and the like are not the primary beneficiaries of these gifts, and the gifting would exist, largely unchanged, without any low income beneficiaries.

The collateralized loan in your example is lower, but I doubt that Austrian economics explains the difference. Some Austrians mistakenly predicted more inflation than we’ve observed, following the incredible growth of Fed’s balance sheet, because they misunderstood the theory behind this growth. The expansive reserves of too-big-to-fail banks were never intended to fuel spending on common, non-durable goods. They’re supposed to sit at the Fed until the Fed is ready to start paying interest on them, giving the Fed another knob to turn in its central planning machinery. That was the plan from the outset.

The loan-to-value ratio does not determine what the interest rate is; the interest rate is instead set by the cost of funds to the lender. I have never met any other banker that works off LTV to set the interest rate that will be charged. What you identified for the landlord is not the loan interest rate; it’s the internal rate of return. The banker does not consider this when making a loan decision; the borrower does.

Regarding the “time preference” of money: Another term for this would be “Yield Curve.” And in a normal interest rate environment, a short-term loan has a lower interest rate than a long-term loan (measured relative to each other). This is doe to both a degree of relative certainty about the asset keeping its value over a shorter term, the likelihood of the loan being repaid, and the likelihood of the currency unit maintaining its value. The shorter the term is, the higher the probability is that the other factors would be closer to 100%.

Incidentally, the reasoning you used in paragraph 2 is used in reverse in paragraph 3. Is this the black hole you were looking for?

The lender in a mortgage transaction is not the proprietor of a scarce substance, like gold, transferring this substance to a home buyer who in turn transfers it to a home seller in exchange for title to the home. This Austrian account of money and credit doesn’t describe the system of money and credit around me.

In reality, money is not a substance distinct from the act of lending. The act of lending creates money. In the case of a home mortgage, the home is the thing lent, not money. Money is a record of this lending, an IOU or a collection of IOUs (promissory bank notes). The money does not exist before the mortgage, and as the borrower accumulates equity in the house, the money ceases to exist. Money is not an elemental substance like gold, obeying some sort of conservation law.

The yield curve reflects the demand vs. the supply for credit of varying terms, but this curve has little to do with savers’ preference for deferred consumption in reality, because the long end of the curve doesn’t really reflect savers deferring consumption for long terms if statutory institutions absorb the long-term debts. Before the Fed and related institutions, there were no 30 year mortgages.

A 30 year Treasury has nothing to do with investors deferring consumption to invest in capital producing goods that the investors want to consume in 30 years. Maybe the bond holders want to defer consumption, but they aren’t creating this capital, and if they only buy the long bond today expecting a monetary authority to pay them more for it tomorrow, that’s not deferring consumption at all.

But a yield curve does exist, and the factors you discuss contribute to it. You may associate this curve with “time preference”, but your time preference is not what Austrian economists call “time preference”. It’s not about savers deferring consumption to invest in capital that will produce goods that savers want to consume in the future.

How does paragraph 3 reverse reasoning in paragraph 2? In paragraph 2, I’m discussing why I don’t identify mortgage interest rates with time preference in a free market. In paragraph 3, I’m discussing why the 4% interest rate is not a free market rate.

Martin, regarding your comment on boom/bust cycles, I was wondering if anyone has read The Fourth Turning? I would recommend.

I see this process a bit more organically then the authors do, meaning it is happening organically for physical reasons of cause and effect, and that this happens naturally anyways, but non the less in this case, is caused by actions from human behavior, and that of course have the same effect.

I think it’s great that Sen. Sanders showed his ignorance early on in the campaign season. The more his (and every other candidates’) ideas are examined with an eye for the detail, the better informed more people will be. But I was most surprised that as a lawmaker, he didn’t understand the concept of collateral. On the other hand, in socialist societies, no one has anything that they can collateralize, so I can expect his ignorance to have been earned in an honest way.

We shouldn’t assume that Sanders is actually this ignorant. Better, and simpler, I think, to assume that he either knows better, or has access to people who know better. If it’s the former, he is deceitful; if the latter, willfully ignorant. In either case, he proves himself unfit to govern. The motivation to say something so stupid is that, if accepted, it would enhance his power and control agenda. He cares nothing for the truth; he cares about power. And, if stupid ideas are broadly accepted, it says more about Americans than it does about their would-be tyrants, who can always be found in every place and time.

Excellent work here. One note though. I understood that student loans (from the government) were not able to be shed through bankruptcy. These loans can and have been used to secure assets from close relatives and shack up associates as well. So I would not classify them as totally unsecured. Neither are they specifically secured by a particular asset. They are a contract that you cannot break, even when you die. Kind of like a bargain with the DEVIL.

@ccspencer
As to Sanders, in comparison to Obama:
Obama is a compelling speaker, and a charismatic salesman. He makes his lies compelling.
Sanders seems like the pinko thug he is.
My fondest wish would be for Trump to obliterate the republicans, and Sanders to return the favor for the democrats. A Trump versus Sanders campaign could be unique, it would be unnecessary for either campaigner to untruthfully disparage his opponent.

@rrule
I have to confess that I have never listened to either Sanders or Obama speaking so I cannot evaluate their respective oratorical skills. You are probably right that Trump vs. Sanders might be amusing. The obliteration of both the Democrat and Republican parties would be something devoutly to be wished! The main problem with such a match up would be that one of them would win.
There would be a certain symmetry in a Communist president being followed by a Fascist. The American people seem to be lurching blindly from one form of socialism to another. The word liberty is not even in their vocabulary.

It may remove all doubt about a number of things but I don’t believe economics is one of them. Anyone who can balance a checkbook knows you can’t create assets from nothing or eat the seed corn and get away with it for long.
It may remove doubt about the socialist’s morality, empathy or concern for people.
You are being too kind to Saunders and his ilk by implying that they are just stupid. They are clever and evil. If we don’t identify them as such, we don’t understand what we are up against and disarm ourselves.

He has a grasp of economics but doesn’t care. I believe economics is merely a descriptive discipline, like physics, describing exchange of values between individuals either singularly or collectively as in a business. However, ethics precedes economics. It gives the “Should” and “What” for exchange.

Sanders believes in “From each according to his ability to each according to his need”– altruism. That ethical principle dominates his thinking on economics. That determines his platform. No surprises. The rhetorical worm he tweeted (“You have families out there paying 6, 8, 10 percent on student debt but you can refinance your homes at 3 percent. What sense is that?”) was bait to catch altruistic voters. Isn’t he implying the rate “should” be more like 3 percent?

The Republican party does the same. Note how often we hear “sacrifice” as a justification for some action or policy. They quibble over details on who should benefit and who should sacrifice, but their ethical principles are the same.

Determine their ethics. That will tell you what drives their economic agendas.

Complicating the issue further, subsidized federal loans have increased tuition prices in part: “. . . institutions more exposed to changes in the subsidized federal loan program increased their tuition disproportionately around these policy changes, with a sizable pass-through effect on tuition of about 65 percent. We also find that Pell Grant aid and the unsubsidized federal loan program have pass-through effects on tuition, “, described in the NY Fed Reserve’s report, “Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs” (sr733.html).

Its interesting that Bernie claims is a supposed non establishment candidate, yet he goes along with all the stupidity nonetheless, and I mean all of it. That being said, I did not at face value think his twitter comment was overly ridiculous. It’s a debt based society, and for that Bernie just plays his part and goes along with it, and gets the birds to chirp. It’s as if they still don’t get it. Taxation is the problem. From people with healthcare problems to car problems, collectively (like that word?) these people are better off spending the money for the fix, but the duopoly created extortion by law, and what’s going to happen when the debt is called in and all social services are cut (that is coming soon)? People will die and extorted more, then they will act like they need more, but these are failed economic policies mixed with corruption. It would be one thing if this ideologue spoke some common sense now and again, but his big government policies are wasteful and what usher in the crippling debt on working families, yet he seems to want more. But would you not agree, that if we have to have a Democrat, it’s better him than the Queen? Rand Paul still has to earn my vote, if I vote at all. Right now looking like I may not vote at all, but what does that get us? I’m thinking George Carlin was right.

Further regulating and subsidizing student loans is only a stepping stone to this ultimate goal, so critiquing the Sanders Plan in terms of conventional finance is futile. That student loans are nominally “unsecured” just isn’t relevant, because a “secured” rate is not the target. The target is zero. A century and more ago, our libertarian forebears similarly critiqued K-12 public education, and here we are.